AUSTIN, Texas--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A' rating on the following bonds issued by the city of Lomita, CA (the city):
--$6.5 million revenue certificates of participation (Water System Improvement Projects) series 2008.
The Rating Outlook is Stable.
SECURITY
The certificates of participation (COPs) are secured by payments made by the city in accordance with the installment purchase agreement. Installment payments are an absolute and unconditional obligation of the city and are backed by a pledge of net water and sewer revenues after payment of operating and maintenance expenses.
KEY RATING DRIVERS
VARIABLE FINANCIAL PERFORMANCE: The system financial profile has fluctuated somewhat due to the rising costs of imported water, inconsistent and still lower than anticipated use of cheaper local source water, and variable capital spending. Debt service coverage (DSC) was sound at 2.8x in fiscal 2015, but is forecast to fall below 1.0x in 2016 before improving to levels more consistent with the current rating.
ADEQUATE LIQUIDITY: Unrestricted cash reserves were adequate at $3.2 million equal to 290 days cash on hand as of fiscal 2015. Nevertheless, cash balances have declined annually over the past five years, largely as a result of cash funded capex.
DECREASED RELIANCE ON IMPORTED WATER: In April 2013, the city's Well No. 5 was put into service and is now providing approximately 30% of the city's water supply, which should help stabilize water costs. Prior to this, the city was 100% reliant on costly imported water from the Metropolitan Water District of Southern California (MWD; water revenue bonds rated 'AA+' with Stable Outlook by Fitch) via the West Basin Municipal Water District.
RATES ABOVE AFFORABILITY THRESHOLD: The current average residential monthly water bill is above Fitch's affordability threshold at 1.5% of median household income (MHI). A recently adopted five-year rate package will keep rates above Fitch's affordability threshold, although user rates are mostly consistent with other regional systems.
NO DROUGHT RATIONING NEEDED THUS FAR: The city's water supply is dependent on an imported water supply, which is subject to availability challenges and cost pressure. However, recent regional investments in storage have thus far insulated the city from the impact of the current severe California drought.
LIMITED BUT STABLE SERVICE AREA: The city is a small but largely built out bedroom community for the Los Angeles and Orange County metropolitan areas.
RATING SENSITIVITIES
DECLINING CASH BALANCES: A continued decline in liquidity at the city of Lomita's water system, which is not balanced by maintenance of solid coverage levels, could lead to negative rating action.
WATER PRODUCTION PROBLEMS: Any issues related to future production of local water, including lower than expected blending ratios or service interruptions, resulting in greater than anticipated purchased water costs or worsened financial metrics could also result in rating pressure.
CREDIT PROFILE
The city is a small bedroom community located about 20 miles south of Los Angeles. The system serves a population of approximately 21,000 through 4,200 connections.
DEBT SERVICE COVERAGE IMPROVING
The city's implementation of a multi-year rate hike beginning in fiscal 2013 has started to pay dividends in the form of improved coverage. All-in DSC finished fiscal 2015 at 2.8x after bottoming at less than 0.9x in fiscal 2012. However, a rate study was performed for the city in early 2015 which projects that DSC will again decline to below 1.0x in fiscal 2016, before DSC climbs to 3.6x by fiscal 2020 with the recent adoption of another multi-year rate hike package.
Fitch views the revenue and expense assumptions in the rate study for fiscal 2016 as particularly conservative, with operating revenues declining by 6% in fiscal 2016 even with a 3% rate increase for the year, and operating expenses increasing by 15% (operating expenses have been steadily declining as the city has moved to gradually blending more local water with costly imported water). The financial forecast also assumes a blending ratio of 60% of imported water to 40% of local water (local production has not yet reached 40%). Thus, any imported water purchases made above these assumed levels could lead to lower coverage ratios if rates are not increased by enough to account for the additional water purchase costs. Nevertheless, the recent adoption of a multi-year rate package with annual rate increases averaging 6% over the fiscal 2016 to 2020 period should help to maintain coverage at adequate levels over the next five years.
LOWER LIQUIDITY LEVELS
As of fiscal year-end 2015, liquidity was adequate at $3.2 million equal to 290 days cash on hand. Although still sound, liquidity has declined over the past five years due to variable capital spending. Per the rate study and capital spending projections provided by the city, cash balances are projected to decline further over the next five years. Fitch's concern about the expected lower liquidity is somewhat mitigated by the forecast higher coverage; however, preservation of sufficient cash reserves to offset unforeseen cash flow interruptions is key to maintenance of the rating.
LOCAL WATER PRODUCTION BEGUN AFTER CONSIDERABLE DELAY
Local water production began in April 2013 after a delay of more than two years resulting in higher than anticipated purchased water costs in fiscals 2011 and 2012. Series 2008 bond proceeds were used to rehabilitate the city's Well No. 5 to provide the city with a local groundwater source in order to reduce imported water costs and construct a new reservoir. However, shortly after it began distributing water in summer of 2010, the well was taken off line due to complaints from the community about odor, taste, and hardness. The city subsequently replaced various water lines and added a dedicated blending pipe.
The city has been gradually reducing its reliance on imported water by using more local water, with local water accounting for 17%, 29% and 32% of the city's total water supply over fiscals 2013, 2014 and 2015, respectively. The city anticipates increasing the proportion of well water to 40% in the very near future.
PRUDENT INCREASES PUSH RATES HIGHER
The city has demonstrated its willingness to raise rates, by passing another five-year rate package for fiscal 2016 through 2020. The package included a 3% increase to the monthly bill (assuming Fitch's standard usage of 7,500 gallons per month) in fiscal 2016, followed by annual increases of 8% through 2020.
The average monthly residential bill is currently above Fitch's affordability threshold at 1.5% of MHI, and will remain elevated over the forecast period with continued annual rate increases. However, water charges compare favorably to other service providers in the area.
MODERATE DEBT; CONTINUED NEEDS
Debt per customer at $1,556 as of fiscal 2015 is low for the rating category and debt amortization is in line with the rating median at 86% of principal paid out in 20 years. Free cash-to-depreciation has been over 100% in the past two fiscal years, which means the system has recently been generating sufficient cash to fund reinvestment. The city has additional capital needs as the majority of the system's pipelines are more than 50 years old and in need of repair and replacement. It plans to spend approximately $3.9 million over the next four years on these projects and does not anticipate additional debt in the near term.
IMPORT DEPENDENT
The city is dependent on imported surface water, exposing it to supply curtailments in a prolonged or severe drought. MWD procures water from the Sacramento-San Joaquin River Delta via the California State Water Project (SWP) and from the Colorado River. Both river systems have been affected by drought in recent years, and the SWP has announced that it will only provide 5% of allocated water in 2014 due to the current drought.
MWD's significant investments in water storage in recent years have allowed customers in Southern California to avoid rationing in the early stages of the drought. The district would have to curtail deliveries if the drought continued at its current, unusual severity, but the supply portfolio appears to be somewhat less vulnerable to typical droughts than previously expected.
STABLE SERVICE AREA
County population growth has been less than 1% per year for the five years ending 2015. County-wide unemployment of 5.5% as of February 2016 is slightly below state (5.7%) but above national (5.1%) averages but has improved from its 2011 peak of 11.8%. City wealth indicators have fallen to slightly below state (93%) but are better than national (105%) averages.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012
U.S. Water and Sewer Revenue Bond Rating Criteria (pub. 03 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869223
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1002842
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002842
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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